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Taxation of Multinational

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Taxation of MultinationalCorporations

Jennifer Blouin

The University of PennsylvaniaUSA

[email protected]

Boston – Delft


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Vol. 6, No. 1 (2011) 1–64c© 2012 J. Blouin

DOI: 10.1561/1400000017

Taxation of Multinational Corporations

Jennifer Blouin

The University of Pennsylvania, USA, [email protected]

Abstract

Multinational taxation is an area of research that encompasses aca-

demics in accounting, finance and economics. In particular, researchers

are interested in determining whether taxation alters where multina-

tional corporations (MNCs) operate their businesses. A review of the

literature on foreign direct investment provides clear support for taxes

influencing MNCs’ location decisions. In addition, MNCs appear to

organize themselves in a manner to increase the amount of their prof-

its invested in relatively lightly taxed jurisdictions. By altering the

location and the character of income across jurisdictions, MNCs are

able to reduce their tax burdens. The natural extension of these lines

of research, then, is determining the welfare consequences of MNCs’

sensitivity to taxation.

This review aggregates the large body of international tax litera-

ture succinctly in one location. Very little of what is incorporated in

this piece is novel. Rather, it borrows heavily from those researchers

who have focused their careers on understanding taxation in the multi-

national context. Unfortunately, because the research in this area is

dominated by work involving U.S. data, the review is also quite U.S.-

centric. However, many countries’ multinational tax rules are quite sim-

ilar. This is primarily attributable to the conformity generated in tax


treaties based on the model treaty outlined by the Organization for

Economic Cooperation and Development (OECD). So, although there

is variation in specific tax rules across jurisdictions, the basic tax rules

are very homogeneous.


Contents

1 Introduction 1

2 U.S. Taxation of Multinational Corporations 5

2.1 Overview 5

2.2 Deferral 7

2.3 Foreign Tax Credit 8

3 Role of Taxation on Investment and Repatriation

Decisions 13

3.1 Investment 13

3.2 Repatriation 20

3.3 An Aside on Havens 33

4 Income Shifting/Transfer Pricing 35

4.1 Theory 37

4.2 Empirical Evidence 38

5 Non-Tax Considerations 45

5.1 Non-tax Issues Related to Location Decision 46

5.2 Accounting Considerations 46

ix


6 Recent Developments in the Taxation

of U.S. Multinational Corporations 53

7 Conclusion 57

References 59


1

Introduction

Multinational taxation is an area of research that encompasses aca-

demics in accounting, finance and economics. Over the years, these

researchers have endeavored to understand the role of taxation on

multinational corporation (“MNC”) behavior. In particular, researchers

are interested in determining whether taxation alters where MNCs’

operate their businesses. A review of the literature on foreign direct

investment provides clear support for taxes influencing MNCs’ loca-

tion decisions. In addition, MNCs appear to organize themselves in

a manner to increase the amount of their profits invested in relatively

lightly taxed jurisdictions. By altering the location and the character of

income across jurisdictions, MNCs are able to reduce their tax burdens.

The natural extension of these lines of research, then, is determining the

welfare consequences of MNCs’ sensitivity to taxation. Ceteris paribus,

investors are better off if an MNC can lower its worldwide tax burden.

Yet, the revenue consequences to the jurisdictions involved are far less

clear.

The central problem of multinational taxation is that there are at

least two jurisdictions that can claim the right to tax the firm’s income.

Firms that only operate within the confines of one jurisdiction face one

1


2 Introduction

set of statutory tax rates. Firms that operate in several jurisdictions are

not only subject to several sets of tax rates but also several sets of tax

regulations. The interplay between rules and rates leads to a multitude

of potential tax obligations facing these firms. As the income of multina-

tional corporations faces overlapping tax claims, MNCs have developed

various avenues for tax avoidance which complicates tax collection by

the tax authorities. Such tax-avoiding behavior may reduce tax revenue

and could distort international financial flows and the international

allocation of investment by MNCs. An important policy question is

to what extent these incentives for tax avoidance actually affect the

behavior of MNCs and reduces tax revenue.

Governments also have been known to use the tax system to both

attract foreign investment and acquire leverage over MNCs’ that they

believe are unfairly escaping taxation in their jurisdiction. Hence,

there are often competing incentives that lead to conflicting objectives

between an MNC’s home country and the countries where they do busi-

ness. Further, many countries are broadly defined to be tax havens.

A tax haven can be any country that reduces its statutory tax rates

to attract foreign investment. Not only does a relatively low tax rate

potentially attract investment, it also likely increases the incentives for

a firm operating in a nearby high-tax jurisdiction to shift its profits out

of the high-tax jurisdiction into its low-tax neighbor. Many legislators

argue that havens are bad for the U.S. But if a U.S. MNC reduces its

foreign tax burden, then, as described below, it is effectively increas-

ing its domestic tax burden. Furthermore, the U.S. and the U.K. are

known to be particularly astute in pursuing taxpayers who appear to

be aggressively undertaking income shifting to low-tax jurisdictions.

Eventually, much of the discussion herein will (hopefully) become

obsolete as countries continue to conform their tax regimes. As dis-

cussed in detail below, there are two basic tax regimes facing multi-

national firms: a territorial system, and a worldwide system. Under a

territorial system, profits are subject to taxation based on where they

are earned regardless of where the ultimate owner (or parent) of the

firm resides. Worldwide taxation, on the other hand, subjects all profits

to taxation in the parent’s home country. At the writing of the review,

the U.S. is the sole member of the G7 with a worldwide system of


3

taxation and corporate tax rate in excess of 30%. Both Japan and the

U.K. adopted territorial tax systems in 2009. Now, over three quarters

of the member nations of the Organization for Economic Coordination

and Development (OECD) have adopted a territorial system of taxa-

tion. The fact that U.S. MNCs not only face a worldwide system of

taxation but also a very high statutory tax rate leads many to believe

that U.S. firms are at a relative disadvantage as compared to their

non-U.S.-domiciled competitors.

The role of this review is to aggregate the large body of international

tax literature succinctly in one location. Very little of what is incor-

porated in this piece is novel. Rather, it borrows heavily from those

researchers who have focused their careers on understanding taxation

in the multinational context. Unfortunately, because the research in

this area is dominated by work involving U.S. data, the review is also

quite U.S.-centric.

However, many countries’ multinational tax rules are quite simi-

lar. This is primarily attributable to the conformity generated in tax

treaties based on the model treaty outlined by the Organization for

Economic Cooperation and Development (OECD). So, although there

is variation in specific tax rules across jurisdictions, the basic tax rules

are very homogeneous.

Much of the prior non-U.S. research used the cross-sectional vari-

ation in countries’ tax rates to garner variation in other jurisdictions’

dividend taxation systems to study the role of shareholder level taxes

on payout policy and share prices (e.g., Lasfer, 2008). However, there

has been a recent uptick in studies involving non-U.S. corporate data.

Because of the availability of Bureau van Dijk’s Orbis, Amadeus and

the Bundesbanks’ datasets, researchers have begun to investigate the

role of cross-border taxation on merger and acquisition activity (e.g.,

Huizinga and Voget, 2009) as well as intra-firm capital structure (e.g.,

Huizinga et al., 2008). I look forward to reading more of this work in

the future.

I begin by outlining all of the (relatively) picky details of taxing

multinational firms in Section 2. My focus, due to the limits of

my knowledge, is on the U.S. tax regime. As the very notion of

multinational implies more than one regime, the consequences of other


4 Introduction

jurisdictions’ tax regimes are also important but, for simplicity, are pre-

sumed to merely be different than that of the U.S. In Section 3 of this

review, I will discuss the theory and the related research on the role

of taxation on foreign direct investment and remittances of profits into

the home country. The incentives to undertake income shifting and/or

transfer pricing will be described in Section 4. Then, in Section 5, I will

address some of the non-tax considerations (including financial account-

ing) of foreign investment decisions. I discuss some current develop-

ments in the multinational tax policy in Section 6. Section 7 concludes.


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